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Shell mulls Chukchi-only drilling for 2014, minus troubled Kulluk rig

The drill rig Kulluk in rough seas off Kodiak Island, where it eventually went aground. Now Shell says that repairs may be too costly to justify the return of the Kulluk to drilling.
USCG photo

If Royal Dutch Shell resumes exploration drilling in Alaska’s offshore Arctic waters, it will do so only in the Chukchi Sea, the company’s chief financial officer said Thursday.

“We have not yet confirmed if we drill in 2014, but we do expect to file an exploration plan shortly, maybe in the next couple of weeks. It’s likely to be focused on the Chukchi,” Shell Chief Financial Officer Simon Henry told reporters in a media teleconference detailing the company’s third-quarter results.

Shell reported third-quarter earnings that were nearly a third lower than those for the third quarter of 2012. The company cited numerous reasons for the drop, including weaker refinery-business conditions, increased upstream operations and exploration costs, challenges in Nigeria and reduced dividends from an LNG venture.

Shell remains bullish on its Alaska prospects, however, Henry said in the London-based teleconference, despite the mishaps, permitting failures and near-disasters that plagued the company throughout the 2012 drill season and quashed any exploration drilling plans for 2013. Even with a new exploration project in a Brazil oilfield named Libra, and plans for heavy-oil expansion in Canada, Alaska “remains the most attractive single opportunity for the future,” Henry said. “Alaska (is) very much on the top of the priority list.”

And top priority in Alaska is the remote and little-explored Chukchi, where Shell acquired leases for $2.1 billion in 2008 and drilled the top portion of a well at its Burger prospect there.

Less attractive, for now, is the Beaufort Sea, where Shell acquired leases in 2005 and 2007 for a combined $84 million and managed in 2012 to drill the top portion of an exploration well at its Sivulliq prospect. “The problem with the Beaufort is it’s too shallow to get normal rigs in. So our focus is very much on the Chukchi, which is by far the biggest prize. That’s the multibillion-barrel prize,” Henry said.

The New Year’s Eve grounding of the Kulluk, the Shell-owned drill ship dedicated to Beaufort operations, was apparently the final blow to the company’s plans to operate there, at least for the foreseeable future. The Kulluk was so badly damaged in the grounding that it may never return to service. It's been in a Singapore shipyard for months.

“We will not take the Kulluk back next year,” Henry said. “The repair costs may exceed the benefits of doing so.”

The so-called “impairment costs” for the Kulluk could be “a few hundred million dollars in the fourth quarter,” he said. Shell is replacing the Kulluk with a leased drill rig, the Polar Pioneer, Henry said. That ship, owned by Transocean, is semi-submersible unit that is nearly square -- 279 feet long and 233 feet wide, according to Transocean’s website.

If Shell pursues Chukchi drilling, it will be done with the Noble Discoverer, the leased drill ship that operated in the Chukchi in 2012, said Megan Baldino, Shell’s Anchorage spokeswoman. The company intends to bring the Noble Discoverer back to Alaska, she said. The Polar Pioneer is intended to be the back-up rig available to drill a relief well, in accordance with federal regulations, Baldino said.

Shell has already spent about $5 billion on its Alaska oil-exploration program, but has managed so far to drill only the top portions of two wells, one in the Chukchi and one in the Beaufort. The company was forbidden by federal authorities to drill into oil-bearing zones because a mandatory oil-containment barge failed to pass U.S. Coast Guard tests in time for the 2012 drilling season.

Henry, in the conference call, said that vessel, the Arctic Challenger, now has regulatory clearance, but that all of the two dozen ships in the fleet that Shell would amass for future Chukchi drilling must also pass new regulatory muster.

At least one Shell critic was unimpressed with the company’s new plans.

"Shell's Arctic bravado is a desperate attempt to reassure its investors, but the facts tell a different story. Brushing off the loss of hundreds of millions of dollars and casually scrapping a drilling platform are not the actions of a company in control of its operations,” Ben Ayliffe, Greenpeace International’s Arctic campaign leader, said in a statement issued hours after Shell’s teleconference.

“In 2012 Shell proved it is completely unfit to drill in the remote Arctic, a place of unrivaled beauty where any spill would be an environmental catastrophe. In April, it signed a joint deal with Russia’s state owned giant Gazprom, one of the world’s most polluting oil companies with a record of serious negligence. Shell has run out of options, and is prepared to gamble its reputation on projects and partnerships that other oil companies have dismissed as far too risky,” Ayliffe said.

If Shell chooses to return to the Chukchi to drill in 2014, it will take more than a new drill ship. Numerous hurdles face Shell, including:

• Significant changes in the way the company intends to operate – including the substitution of another drill ship for the Kulluk – mean Shell will need to change its official exploration plan, a document requiring the approval of the Bureau of Ocean Energy Management. “If Shell wants to resume drilling, that would require a revised EP,” said John Callahan, an Anchorage BOEM spokesman.

• Shell will need other permits, including replacements for one-year authorizations that expired or will soon. Those include permits from the National Marine Fisheries Service and U.S. Fish and Wildlife Service allowing the company to operate around protected marine mammals. Potentially more complicated will be new authorizations for air emissions. Air-quality permitting has been difficult for Shell, which wound up paying $1.1 million for Clean Air Act violations committed in 2012. An initial permit for the Discoverer, issued by the Environmental Protection Agency, was deemed inadequate and was overturned at the end of 2010 by that agency’s Environmental Appeals Board. A rewritten permit was issued in late 2011 – and modified, at Shell’s request, just before 2012 drilling started. But Shell could not meet even those loosened rules. Thanks to a legislative rider pushed through at the end of 2011 by Sen. Lisa Murkowski, air-quality oversight for Alaska outer continental shelf oil operators is now the responsibility of the BOEM, not the EPA. http://yosemite.epa.gov/R10/airpage.nsf/Permits/chukchiap/

• Shell must comply with yet-to-be-issued Arctic-specific rules for future oil and gas activities. Those rules are expected to be released by BOEM before the end of the year, and are expected to cover travel to and from the Arctic -- as well as any activities by drillers. The rules are being drafted in response to a Department of Interior investigation into the Kulluk grounding and Shell’s other 2012 woes.

• Shell may have to wait for outcomes of a separate investigation launched by the U.S. Coast Guard into the Kulluk grounding and unrelated environmental and safety problems found on the Discoverer. There may have been violations of the International Convention for the Prevention of Pollution from Ships, known as MARPOL, aboard the Kulluk, Coast Guard Rear Admiral Thomas Ostebo said in March. Coast Guard inspectors were so unhappy with what they found aboard the Discoverer last winter that they detained that drill ship for weeks in Seward. The Coast Guard forwarded information to the Justice Department; it is unclear whether there will be further legal action beyond the air-quality penalties already imposed.

• Lingering legal questions remain about whether the 2008 lease sale held by the Minerals Management Service (MMS) was valid. U.S. District Court Judge Ralph Beistline ruled in 2010 that the sale would be valid only if the BOEM, the MMS’ successor agency, conducted remedial environmental and economic studies to make up for pre-sale omissions and lapses. Last year, Beistline found that BOEM’s work – a supplemental environmental impact statement and a revision of that study -- was adequate and that the sale conducted in 2008 was valid, albeit retroactively. Now the 9th Circuit Court of Appeals is considering the question. “We expect a decision more or less any day,” said Michael LeVine, Juneau-based Pacific legal counsel for Oceana, one of the environmental groups challenging the lease sale and preparations for it. Possible results from the 9th Circuit court range from an invalidation of the entire lease sale – a drastic outcome that could trigger lease buybacks – to a full approval of the lease sale and preparatory work to date.